Race to the (Divorce) Finish Line

game-finish-lineAs preliminary versions of the new tax bill were released, it was apparent that big changes were on the horizon in the spousal support (alimony) arena. The prospect had attorneys scrambling to have divorces completed by December 31, 2017 in order to insure that the deductibility of alimony payments was “grandfathered” under the old tax law. A slight reprieve was granted under the final bill that was ultimately signed into law. The deduction for alimony now ends for divorces completed after December 31, 2018. Now there is a race to a new finish line.

Under current tax law, the payer can deduct the full amount of alimony paid and the recipient must include the full amount in their taxable income. Under the new law, alimony paid by one spouse to another will no longer be deductible and the spouse receiving the alimony no longer has to pay taxes on it. In theory, that sounds good for the payee. However, that will probably prove not to be the case. Since the amount will not be deductible by paying spouse, the courts will most certainly look to a lower amount (the net out of pocket cost) when they award spousal support. Having no deduction, will significantly reduce the net amount, available from the paying spouse. Hence, expected lower payments to the payee.

As an example (in simplistic terms):

If a high income spouse was paying alimony of $90,000, assuming a marginal tax rate of 39.6%, the net out of pocket cost to that spouse would be assumed to be $54,360. Assuming the recipient’s only income is the alimony, the net received after taxes (all other things being equal – no consideration given to other deductions) would be approximately $70,000 (assuming a blended tax rate). The courts will now probably use the net out of pocket (or some similar variation thereof) for the payer in computing the affordable support.   You can see how this could be a very large potential decrease in income for the payee (almost $16,000 in this example), even though the income is no longer taxable to the payee.

The most recent data I have found (from 2015) shows that around 600,000 taxpayers took the alimony deduction amounting to more than $12 billion. Even a 10% rate disparity between the payer and recipient in the tax rate from higher payer individual to lower tax rate individual represents over a billion dollars in tax revenue having been lost (and, in all likelihood, the rate differential is even higher). The IRS, in essence, was subsidizing alimony payments. No more! It’s no surprise that this was an easy target to raise revenue to try to offset some of the tax cuts.

In NY, there is a calculation to determine appropriate payments. So time is of the essence. In other states there may be more negotiations needed which could prove to be quite contentious.

The law does not take effect until 2019. That could set up a wild 2018 year as divorcing parties, and their attorney alike, race to the finish.

Tracy Badgley, CPA, CGMA, CDFA